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Fannie and Freddie have been around for a very long time. They've operated as
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private entities, shareholder entities with an implicit guarantee but specifically without an explicit
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government guarantee so that they were not in fact federally owned organizations
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or controlled organizations, but as of September 8th, 2000 and 8 strike that, as of September 7th, 2008
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they they came under government control. With the crisis in the overall housing market, with the demise of Lehman
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it was clear that Fannie and Freddie were illiquid, ill insolvent, and required a government intervention to
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prevent their meltdown, which of course would have brought down the entire housing market. At the time the housing
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market was in freefall, but this would have clearly without support of Fannie and Freddie taken a great recession and
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made it into great depression 2.0. The intervention was necessary. At that point, Fannie Freddie became regulated
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entities and controlled by the Federal Housing Finance Agency, FHFA which is a separate independent entity,
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and Fannie and Freddie are now under conservatorship directed by FHFA. Clearly keeping FHFA in the oversight
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position forever with Fannie and Freddie in a conservatorship what that means is
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that the taxpayers on the line for all losses, totally on the line for losses in Fannie and Freddie. And this is not a
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long-run viable solution. Having basically a nationalized housing finance system is not something that's
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viable for the long run for the United States. So, alternatives are must be considered and are being
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considered. But they range from one side of the spectrum to the other side of spectrum,
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and getting to consensus is been problematic. Well, there are and the dialogue has
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evolved on this. And there are broad areas of agreement, not perhaps 100% but among many parties, again across the
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political spectrum there has uh agreement has come about on some very important aspects of how to reform
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Fannie and Freddie. First, the need for a 30-year fixed-rate mortgage going forward, that this is an
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instrument that provides protections to homeowners and that it there is a need for this mortgage product in the United
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States. Uh secondly, the need for a liquid mortgage-backed securitization market to
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support the 30-year fixed-rate mortgage. Third, the need for private capital to be in a first-loss position
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so that the taxpayer is not on the hook, but in fact private capital, appropriately so, takes the risk and if
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uh puts and and evaluates what the risk is and charges appropriately for the risk in
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mortgage rates and in mortgage insurance rates. This is private markets' role of
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setting up incentives and and taking on losses appropriately. So, that's a second key. A third key is
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that when there's a catastrophe, that that's the role for the government
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to be there in place for a catastrophic risk occurrence. And this consensus that that's the
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appropriate role for the government, and only appropriate role for the government
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to step in. In addition to this, to hopefully ensure a more stable market going forward there's a consensus on the
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need for transparency. A platform for standardization of mortgage-backed securities mortgage
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terms and a public uh le available set of characteristics of the mortgages and the
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mortgage-backed securitization. Some sort of utility that would be able to verify mortgage terms over time and and
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put into place standards for mortgages and mortgage-backed securitization. And finally, there is some agreement for
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some role for affordable housing. So, the combination of factors that there is agreement on is pretty
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substantial at this point, but the implementation of how do we get there is where there's a great deal of
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disagreement. There are two major proposals that are uh that have gotten some support. The first
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is the um uh protecting of the American Taxpayer and Homeowner Act, which was introduced
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by Hensarling in the House in 2013. Uh and that did come out of the House Committee on
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Financial Services. It hasn't made it any further than that. Uh that proposal is basically to privatize
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Fannie and Freddie entirely, to withdraw support for Fannie and Freddie 100%. They would have no no no support,
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implicit or explicit. Uh there would be a common securitization platform, a utility that
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the proposal calls for, and the utility would support mortgage securitization standardization. It wouldn't impose
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standardization, but it would make whatever mortgage-backed security standards were being used,
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make them transparent and and and call for the mortgage lenders and securitizers to
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abide by whatever standards were set out. But that's as far as the government
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or public would go, just set up utility to oversee the securitization platform that was
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that was put forth. The second proposal, the second major proposal is by Johnson-Crapo, and it received support
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across the political spectrum. However, did not receive sufficient support to come out of the Senate Banking Committee
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this past spring in 2014. But it it did go very far along in terms of getting consensus among many parties.
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There are still obviously points of major disagreement, which is why it did not come out of committee. But to first
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go to the points of agreement that were embodied in this first of all, there's a first-loss capital
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in private capital in the first-loss position, very key. Secondly, some provision for affordable housing.
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Third, a platform for trading a single security that would be have to be approved by a regulator, to
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be very much like the FDIC, with Federal Mortgage Insurance Corporation, which would insure mortgages that were then
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would be explicitly guaranteed by the federal government. MBS that would then trade would be
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insured by by aggregators who would have to be approved also by FMIC. There would
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then be competition among the aggregators to provide for the to provide mortgage-backed securities at
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and and also the corporations that provided the the insurance for the mortgage-backed securities would trade
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and there would be private capital up front. So, this proposal, in fact, if you went go through the the different
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positions of consensus that we discussed earlier, goes very far along in embodying those positions of consensus.
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And in fact, it was the run-up to the Johnson-Crapo Act that I think brought about the sense of okay, this
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among this is this is what we can agree on. So, that's really where the state of the debate is
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at this moment. In the Johnson-Crapo proposal, the mortgage-backed securities are insured
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explicitly by the federal government under the regulation of the new entity Federal Mortgage Insurance Corporation,
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similar to the FDIC providing insurance for demand deposits. And the borrower ultimately pays
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in mortgage rates for an insurance fee, which is then paid to the federal government to the entity that's
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overseeing the CFMIC, which means of course that investors are not receiving, they must pay through the aggregators.
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The aggregators must pay up front an insurance fee to the federal government for the right to this explicit insurance
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in case of catastrophic risk. And this so what it so the ultimate is that the mortgage-backed securitized
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securities that are trading have no risk to the investor to the in the mortgage-backed securities because these
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are fully guaranteed explicitly by the federal government. In order for the uh the aggregators to receive this
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insurance, to get the stamp of approval by the federal government, the eagle stamped on their mortgage-backed
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securities, to make them no credit risk, zero default risk to the investor, they must pay for insurance
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from the federal government. And also they must abide by standards set up by the FMIC as
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well. Well, there is a one one very large question. What should be the risk premium? And of course there's similar
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questions over demand deposits. What should be the risk premium for FDIC? And whether this risk premium will be
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priced accurately over the cycle. These are all very large questions. And then there are two other related questions
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which are um well, will there be lenders who are issuing mortgage-backed securities that
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do not have government insurance? And will those expand over the cycle because they will be competitively at an
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advantage since they do not have to pay the tax? And there is nothing in this legislation
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which prevents that. The implementation questions of course are key. One question of implementation
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which was perhaps one of the reasons why in the end Johnson-Crapo did not get out
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of committee is where's the private capital to support the first loss position which in the legislation is
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required to be 10%. The mortgage-backed securities market is last estimated $5 trillion. That's $500 billion. Where is
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that capital going to come from? Who's volunteering to put up $500 billion worth of first loss capital equity to
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take the losses in front of the government. So that's one question. A second question is what's the guarantee
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fee? And of course that will affect the profitability of the mortgages and the interest and willingness of private
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capital to come to the game. Uh the and a third question is well, what about all
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the other mortgages out there that could be issued and securitized without a tax?
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Will they compete against the mortgages that do receive the explicit insurance and will that competition be
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pro-cyclical? That is will these mortgages expand during the boom period of the cycle? And then during the bust
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period they'll be out there uninsured and potentially causing systemic risk.
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So that I think was the one of the most important questions that was brought to the structure of Johnson-Crapo. But a
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second important question was where's the role for affordable housing? Both of those questions get back to an
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underlying uh aspect of the proposal which is this single security which is a to be um implemented,
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regulated, overseen by the federal government since it would receive the federal government's explicit backing.
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Well, who is in fact overseeing the single security? What are the characteristics
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of a single security? What is the risk? What are the terms? And do these vary among the insurers,
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the aggregators that are participating in this market and that are putting up the first loss position?
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If so, do we actually have a liquid market for the mortgage-backed securities that
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allow a 30-year fixed-rate mortgage? Those were all questions which the legislation as close as it got to being
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uh to coming out of the committee at that point, these questions were raised in terms of the
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pretty much the fundamentals of the of the proposal which go to the question would in fact such a uh imp such a such
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a structure support the 30-year fixed-rate mortgage? Would such a structure be stable over the cycle? And
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third, would such a structure support affordable financing or more simply financing
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broadly available for those who qualify over the cycle? And those were all questions which are yet to be answered
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and still have to be addressed before a consensus can emerge. Well, there's a real range of um
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estimates on that and some estimate that it will be de minimis and some estimate
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that it will be several hundred basis points which of course would be uh would make these non-competitive against
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uh securitizations that did not need to pay 100-200 basis point tax. Uh to my mind the question is how are they
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priced over the cycle? So it's not just a question of a static pricing. It's a
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dynamic pricing. And that of course depends on how risky the overall market becomes which depends on the entry and
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the withdrawal of capital into this market from other sources. So it's a very difficult question to answer
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without answering that other question of what's the structure of the mortgage-backed securitization market
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over the cycle. One I just reform Fannie and Freddie. Uh question is what do we mean by reform?
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There is some consensus on what we might mean by reform, no portfolio going forward. And we're moving in that
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direction in any case and that's where the riskiest loans were. Uh a second part of the uh consensus is that there
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should be transparency in the mortgage-backed securities. There should be a common securitization platform to
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provide transparency so we can track what loans are in fact being securitized going forward. And that too is in place.
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Uh but then the third component is really where there is big questions which is how do we get
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private capital into Fannie and Freddie to take the first loss because there is consensus that there should be private
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capital at risk prior to the taxpayer. That's a key point where there's major
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disagreement and part of this major disagreement because it it hinges on the question who owns
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Fannie and Freddie? And there are major lawsuits right now on who owns Fannie and Freddie that need to be resolved.
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And there may also need to be congressional weighing in on that question of who owns Fannie and Freddie
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because Fannie and Freddie were originally chartered and still are chartered through Congress. These are federal
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national charters which are not state chartered but chartered by Congress. So we will need
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Congress to weigh in on that. However, there is um there is movement as we speak in terms
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of that third component of bringing at risk capital, private capital. And both Fannie and Freddie have instituted a new
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uh uh uh a new derive um a new security uh just for that purpose to bring private
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capital in in front of the taxpayer. Uh those are trading and they are in fact um bringing private capital in to to
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take first loss credit risk and to price that credit risk and to do so transparently. This is
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a new development and it's it's um increasing very rapidly. So in fact while it seems as though nothing is
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happening, much is happening. Uh these new instruments uh go by the name of STACR and uh in the case of um
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uh of uh Freddie and Connecticut Avenue securities in case of of um Fannie. And they are um very large at this point
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and they're taking a major share of the credit risk of both entities. Uh and of the new issues of of both
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entities. So this is a very good development because in fact what we do need is we do need not only regulators
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to oversee the risk of the mortgage market, we need a transparent way for private capital to uh price and reveal
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the pricing of the risk of the credit of the mortgages that are being issued and
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either implicitly or explicitly uh being supported by the federal government.